CHAPTER TWO – Federal
Transfer Tax Structure
Federal tax structures:
1) Transfer taxes –
- Estate tax (transfers at time of death)
- Gift tax (transfers during lifetime)
- Generation skipping transfer tax (GSTT)
2) Income tax –
- Tax basis rules (§§ 1014, 1015)
- §102 – inheritances & gifts as gross income
- Subchapter J – trust income taxation
- “Assignment of income” doctrine
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Evolution of the Current
Federal Estate Tax
Pre-2001 (exemption up to $700,000)
Pre-2010 (2002 thru 2009, increasing exclusion,
to $3.5 million)
The year 2010 – repeal (but carryover basis
applies); then, 2011 back to 2001 regime.
Cf., retention of the gift tax during phase-out.
But, then, 2010 Tax Act - 12-17-2010
Estate tax restored, $5 million exclusion,
including for gift tax; $5.12 mil for 2012.
Then 2012/ 2013 legislation.
A “permanent fix”?
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Objectives in Imposing
the Federal Estate Tax
1) Revenue – How much? $30 Billion? $8
billion? What % of total federal tax
revenue? Is the % amount relevant for tax
policy reasons?
2) Consider: Economically accrued “income”
not previously subject to income tax, e.g.,
§1014 basis step-up; i.e., “tax justice.”
3) Reduction of wealth concentration – is this a
valid objective/public policy concern?
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Economic Effects of the
Estate Tax
Is the estate tax detrimental to small business?
See analysis, p. 8 (JEC-Republicans, 2003)
Are small businesses and family farms actually
being impeded by estate tax?
What is a “small business” for this purpose?
Cf., recent argument re income tax on
taxpayers at top rate ($400,000+, as indexed),
and the impact on small businesses.
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Alternatives to Estate Tax
(“Death Tax”)
p.9
Inheritance tax – imposed on the recipient; tax
rate is based on the relationship of recipient to
the decedent. But, collection occurs at source.
Accessions tax – tax on the cumulative total of
value received by a person during lifetime.
Income tax - inclusion in the gross income of a
bequest (& gift) amount (i.e., repeal IRC §102).
Net worth tax (imposed on a periodic basis) –
a property ownership tax. Constitutionality?
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Effect of Carryover Basis
(vs. Estate Tax)
p.11
Estate tax: imposed at the rate of (then) 35%
above a $5.0 mil. exemption equivalent.
Carryover basis structure (2010): Capital
gains rate (then 15%) above a minimum basis
step-up allowance amount; deferred income
tax (& consider value of deferral). Most opted
for carryover basis.
See §1022 re carryover basis (& exceptions).
But, downward shifting of tax liability? P.11.
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Structure of the Federal
Estate Tax
p.12
Computation:
Gross estate
Less: Deductions
Equals: Taxable estate
Less: Credits
Equals: Net estate tax liability.
Note similarity to the net income tax structure.
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Gross Estate Defined “economic rights”?
p.12
Gross estate inclusion (§2031):
-Probate assets – property owned directly -§2033
i.e., property where the decedent has an interest.
- tax-exempt bonds?
- accrued rent and interest income?
- other assets, e.g. contingent claims
-Some transfers made within 3 years of death –
- including the gift tax paid - § 2035(b); gift tax
as tax “exclusive” tax. Estate tax as “inclusive.”
-Cf.,
income
tax
is
imposed
on
a
pre-tax
amount.
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Gross Estate Defined “economic rights”?
p.15
Gross estate inclusion: §§2036-2038
-Transfers with retained interest/controls
(1) Grantor retained economic interests
E.g, a revocable (“living”) trust
- a retained income & corpus interest
(2) Grantor retains controls
E.g., retained right to control distributions.
-Survivorship annuities - §2039
applies to annuity with a survivorship
payment; cf., treatment of a single life annuity
for the decedent. (c) William P. Streng
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Gross Estate Defined “economic rights”?
p.16
Gross estate inclusion for:
- JTWROS property (decedent’s funds) - §2040
Issue: Who provided the consideration?
- “Power of appointment” property - §2041
property is subject to a decedent’s control but is originally sourced from another.
- Life insurance proceeds - §2042 p.17
if decedent holds “incidents of ownership.”
- Transfers from the decedent’s spouse - §2044
(see §2056 enabling prior marital deduction)
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Deductions reducing the
gross estate
p.18
- Expenses & debts (genuine debts?) §2053
- Losses (e.g., casualties incurred during
administration) - §2054
- Charitable transfers – §2055 - no limit on this
deduction (including split-interest gifts)
- Spousal transfers (QTIP trusts) §2056
- State death taxes (not relevant in Texas);
Prior credit for state death taxes. (p. 22).
Cf., credit for foreign tax paid - §2014. (p. 23).
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Estate tax liability
computation
p.19
§2051 – taxable estate defined.
Cumulative transfer tax base – including prior
lifetime gift transfers (a unified tax base).
Credit for gift tax on prior lifetime transfers.
Less: Other credits (i.e., unified credit &
foreign tax credit; previously for state death tax
paid), p.22
Cf., federal gift tax (tax exclusive applicability)
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Federal Gift Tax
p.24
40% above $5 million+
§2501 – imposition of this tax on gifts- imposed
on a lifetime, cumulative basis. Still applied in
2010 when the estate tax was repealed. Why?
Certain exclusions (e.g., annual donee exclusion)
& deductions are available.
& $5 million exclusion (as indexed).
Smith case (p.25) – re effect of subsequent gift
tax revaluations on the estate tax calculation
(i.e., applicable tax rate and offset for gift tax
payable); & the legislative response - §2001(f).
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Generation skipping
transfer tax
p.37
Purpose of the GSTT?
Situations where GSTT is applicable –
(1) during lifetime, (2) at death, & (3) when a
later trust distribution.
A separate GSTT is imposed (in addition to
other transfer taxes).
Code §§2601-2604 (expired for year 2010).
Reinstated for 2011 & later - $5 million
exemption, as indexed.
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Relevance of State
Property & Inheritance
Laws to Estate Planning?
How define the governing state law? Consider
the Bosch case impact: state lower court
proceedings determine the “property facts.”
When is the federal tax proceeding bound by
the applicable state law? Cf., Erie v. Tompkins.
Can the IRS be bound by prior proceedings in a
state probate (or other) court? If not a party?
Bosch case (p.38): “proper regard” treatment is
required for the related state court proceeding.
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Conflict of laws issues
p.43
Choices of applicable law issues arising in:
1) the property transfer/probate context?
2) Federal transfer tax context (consider the
Bosch case)?
3) State estate/inheritance tax context?
Examples:
Land, e.g., 2nd home or ranch in other state;
Corporate stock certificate (or equivalent);
Other intangibles located outside home
state.
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Conflict of law issues,
Special considerations
Note: community property issues (i.e.,
identifying community property, including
when transported across state lines into a
separate property jurisdiction); or when
moving from separate to community state.
Use planning to change the situs of property
(e.g., with revocable trust ownership
governed by law of other state)?
What property law treatment of U.S. Treasury
bonds/notes – a special federal property
regime?
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Valuation Issues
p.44
What is an appropriate valuation approach for
federal estate tax purposes? See Reg. §20.20311(b) re willing buyer-willing seller valuation
definition.
What assets present valuation difficulties?
How is this valuation to occur?
Consider the O’Keeffe case (p.45) & similar
decisions (e.g., art, real estate and FLPs). How
does the taxpayer’s counsel develop an estate
tax valuation case before/during litigation?
Other valuation issues? M. Jackson’s “name”?
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Valuation & the Impact
of Built-in Tax Costs
How value corporate stock when the “inside
assets” have significant accrued appreciation?
(See p. 56).
Note: Corporate cap gains tax at 35%.
See Dunn case (p. 57) in the 5th Circuit, &
similar decisions. What relevance (if any) of
the expectation of a near-term sale of the assets
inside the corporation?
How is stock valued by a prospective buyer in
an anticipated stock purchase transaction?
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Valuation of Split
Interests in Property p.60
How proceed to value a split interest in
property (vertical; horizontal)?
E.g., ownership of only a partial interest:
1) a lead interest,
2) a remainder interest (after a term or after a
life?), or
3) a reversionary interest?
See Reg. §20.2031-7(d)(6), Table B & (d)(7),
Table S; what exceptions apply to the use of
these tables? See O’Reilly case, p. 61.
What is the impact(c)of
high/low interest rates?
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Federal Income Tax –
Gifts & Bequests
p.61
Gifts & bequests are not included in gross
income - §102 – even though they constitute an
“accession to wealth.” Except, see §2801 re
gifts from expatriates.
What about the “income” subsequently derived
from gift/bequest property? Gift of an “income
stream” (e.g., life interest)?
See §102(b) – no exclusion is available for the
income component from property received in
gratuitous transfers.
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Income Tax Basis Issues
p.62
Income tax basis step-up at death? See §1014
(pre and post-2010). No gain recognition.
What tax expenditure cost?
Note (p. 63) the 2015 enactment of §1014(d)(9)
re consistency rule (enacted in Surface
Transportation Act).
Other options re tax basis at death? P. 63.
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Income Tax Basis Issues
Connecticut National Bank case, p. 63.
What application of §1014 when funding
delayed?
Cf., the carryover basis rule applicable during
2010 (§1022), if an election out of estate tax was
made. See next slide.
What about IRD? See §1014(c) & §691
providing for GI inclusion (for a cash basis
taxpayer; cf., accrual basis taxpayer). E.g.,
deferred compensation.
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Carryover Basis at Death
§1022 – for 2010
P.68
Applicable for 2010 if electing out of estate tax.
Recipient obtains the decedent’s basis for
acquired property, except lower for lesser
fair market value.
Special tax basis increases under §1022:
1) $1.3 million value, with increase for unused
built-in losses and loss carryovers;
2) $3.0 mil. transfers to surviving spouse.
How allocate this stepped-up basis to the
various properties? How protect the
executor in making this allocation?
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Gifts & Transferred
Income Tax Basis
p.69
What about transferred tax basis to a donee for
intervivos gifts? See §1015. & Taft v. Bowers.
See §7701(a)(43) re transferred basis property –
received from the donor.
§1015(d)(6) – special adjustment for that gift tax
(if any) attributable to the appreciation
component of gifted property.
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Estate Tax Administration
Issues
1) Estate tax return filing requirements –
responsibility of the executor.
2) Audit examinations by IRS?
3) Possible to obtain an estate or gift tax
private letter ruling (i.e., in advance) from
IRS? P. 70.
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WWWWW
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